Bitcoin skyrocketing because of limited supply?

There are some suspect arguments regarding why Bitcoin must rally or must not rally that I’d thought I’d address below:

Argument: Bitcoin must rally because the supply is limited.Counter: The problem with this argument is that it is known and has been known since inception that the supply is limited. Markets are forward looking. Only new information can change the equation. In the recent run-up, many analysts point to the new use-case of Chinese speculators and investors as the reason for the run-up.

Argument: Bitcoin must be valuable because it is rare.Counter: I can create a unique search string that Google, the entire internet, has never produced. I bet you can too. Something rare or unique isn’t inherently valuable.

Argument: The governments will never allow Bitcoin or they won’t allow it to become too valuable.Counter: A reasonable argument but it didn’t hold at $500, $1000, $1500, $2000, $3000. The argument may or may not be valid but unless it is specific then it offers no trading insight or value.

Argument: Bitcoin is a bubble.Counter: Very possible but if it manages to go to $30,000 that’s a ton of profit potential. This information is only useful for someone who plans to hold Bitcoin until it goes to zero. Any asset eventually might go to zero. This doesn’t help quantify the risk and opportunity. The risks are exceptional but the rewards could be too.

Argument: Bitcoin is useless. Only speculators, drug dealers, or people in countries with unstable money use it.Counter: This proves Bitcoin has utility.

Argument: Anyone can duplicate Bitcoin so it has no value other then cheap brand recognition.Counter: Every transaction adds to the security. While it is possible to create new cryptos, they are not all equal. Most exchanges won’t support just any crypto and most people will buy Bitcoin through the major exchanges such as Coinbase. Yes, Bitcoin likely benefits from name and network value, as well.

Argument: If Bitcoin has utility today then it will always hold utility.Counter: This is likely going to be true for a long time. However, it doesn’t tell us at what price. Bitcoin was sub $1,000 and even sub $300 for much of its lifetime. Also, Bitcoin is not a static system. There are spin-offs, competitors, and also network changes, such as the decreasing percentage of coins mined, that could change the situation in the future.

Argument: Bitcoin costs a lot of money to mine so it must hold its value.Counter: The fact it costs money to mine forces miners to sell. A large supply is created everyday that must be sold. I believe the algorithm is adaptive. This does suggest a marginal price floor, however where miners would quit mining. Bitcoin is inflationary.

Argument: You can’t just create something of value from nothing. Bitcoin cannot possibly be worth anything because it was never worth anything.Counter: In fact, you can because Bitcoin exist and has as a quite high value today. Ideas are routinely created from nothing and have great value. Most ideas do fail eventually, however.

Argument: Eventually, there won’t be any more Bitcoin to mine. And, it will shoot to the moon then.Counter: The fact that Bitcoin can be mined is actually a strong argument against it being regulated away. However, if it couldn’t be mined then it would be much easier to be regulated away. A coin with true utility, such as a super computing based coin for useful tasks, would be very difficult to regulate because it would have value even if never converted to any other currency. and it would have intrinsic utility — unlike Bitcoin. Also, Bitcoin is not a static entity. There is no guarantee that the miners, who have an incentive to keep mining, won’t just vote to increase the supply.

Argument: The network effect explains Bitcoin’s value. As more and more people use it then it must become more valuable.Counter: I think there is some merit to this argument. However, the natural way to see this is that if a dominant company establishes monopoly advantage then a competitor can’t compete because they can’t grow faster then the monopoly company can steal their good ideas and/or the monopoly can exhaust the competitors supply of resources. Bitcoin’s decentralized nature doesn’t allow it to benefit from its monopoly advantage in all of the ways that a company can. If Bitcoin were a company, it would have filed patents making things difficult for the new startups. If it were a company, it would be easy for it to incorporate new ideas to address its shortcomings and it wouldn’t be forking and competing with itself. More over, one can see the network effect is not foolproof when you look back at the history of formerly dominant companies and products that are no longer such as Alta Vista, MySpace, and Yahoo (for search). Other examples might be the computer “desktop” which is now threatened by cloud based apps. Beyond that argument, even if true it doesn’t tell us how much to the “far right” that speculators have already pushed prices. The network value is probably lagging to the far left. If new use cases are found and/or it becomes more popular then the higher prices might one day be justified. On the other hand, it might be priced beyond all future value already today.

Argument: A lot of big billionaires and companies have invested in Bitcoin and believe in it.Counter: Actually, most of these investments are not about speculating on the price of Bitcoin but allowing others to do so or building tools or software or infrastructure based on either the technology or similar technology.

Disclaimer: There is potential for exceptional risks in such products. Risks can be price based but also exchange based, regulation, and unknown risks.

About the Author

Curtis is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact him at curtis@beyondbacktesting.com.

Some great points. The main flaw with BTC as I see it is that the difficulty of “mining” bitcoin is determined by some algo. What happens when technology moves in expected ways, and the algo breaks? There’s no way, for example, that someone could have created an adaptive algo in the ’70s that would have held the difficulty level constant over time through today. Yet that’s what the Bitcoiners believe will happen over the next few decades, as far as I can tell. Am I wrong?

@evo34 I haven’t studied it in any depth. However, I think the way it works is that to fabricate one Bitcoin, you have to go back and change every block. It would cost more in energy then it is worth. The only ways you could break it would be a man-in-middle attack or there is talk of a 51% attack (if any single miner controls 51% of the network they might could do something). I think it is unlikely Bitcoin would be truly broken. The only possibility is would be quantum computers become super powerful and maybe not even then. It would take a quantum super computer. Of course, the common argument is that the blockchain is a great technology but Bitcoin itself isn’t special. They have a point, anyone can create a new crypto. The argument goes as anyone can do it then Bitcoin should never have gained any value in the first place. Real currencies are different in that they are more or less mandates.

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